The Greek election on May 6 delivered a result that was only marginally surprising, defeating both "establishment parties," the center-right New Democracy and the Socialists, or PASOK. Together they fell short of a majority, with only 108 seats for New Democracy and 41 for the Socialists, out of 300 parliamentary seats. 1 Because it is unlikely that any government can be formed among the seven parties in the parliament, new elections will have to be held soon. The outlook is more uncertain than ever, and the risk of a potential Greek exit from the euro area has increased.
When faced with this type of electoral upset in small member states, the EU has historically adopted two distinct response strategies, one aimed at voters and the other aimed at recalcitrant political leaders. The first strategy was employed in 2009 when the Irish first rejected the Lisbon Treaty reforming the European Union. Subsequently, when a few meaningless revisions were added to the Treaty, the Irish voters adopted it in a second referendum. It was the threat of economic and political isolation that persuaded them to change their mind. The second strategy unfolded at Cannes last year. It was then that the EU threatened Greek political leaders with economic ruin (in the form of a euro exit) in order to force them to rethink their response. Both these strategies were designed to overcome member state democratic processes and get to the "right answer" for the European Union as a whole.
We are about to see both these strategies potentially applied to Greece, ushering in a period of intense political instability in the euro area as this one or two-stage game of chicken gets under way.
As new elections in Greece now look overwhelmingly likely, we will first see the Irish referendum strategy played out focused on the Greek electorate. Alexis Tsipras, leader of the leftist anti-IMF program Syriza party, which came second in the Greek elections, has clearly articulated that he intends to annul the IMF program and cancel all loan agreements2. He expects to call the euro area's bluff by threatening economic ruin on the rest of Europe to force a renegotiation easier on Greece. For several reasons, this strategy is unlikely to work.
Threatening market chaos if its demands are rejected is much less credible than earlier in the crisis, for example. Following the Greek debt restructuring in March, most of the private losses from Greece's bankruptcy have already been realized. Euro area banks are well funded with ECB 3-year liquidity. The immediate cross-border financial market spill-overs from the end to the current IMF program and another Greek default will likely be smaller today than they would have been last November.
If an outright Greek euro exit were seriously contemplated, however, the euro area would have to take additional institutional measures to protect itself from the risk to its currency. Euro area leaders would have to redouble their commitment to keeping the diminished euro "inseparable and forever." The euro area would have to accelerate its economic and institutional integration by, for example, introducing a pan-euro area banking deposit insurance scheme to prevent bank runs in other peripheral countries when Greek euro deposits are suddenly converted into new drachma. There would also have to be a clear time table for eurobonds. Ironically, by forcing Europe to prepare for threatened chaos, a Greek exit would have a positive impact on the integration of the rest of the euro area.
Euro area taxpayers are increasingly playing the role of sole junior Greek creditor. If one believes that Greece is ultimately not going to be able to commit to its IMF program, it would be in the taxpayers' interest to cut off funding as early as possible to prevent having to take bigger losses in the future. This is crucial because large transfers to recapitalize Greek banks (€25-50 billion) are otherwise planned in the near future. Ending the IMF program payments to the Greek government early and instead relying on the separate escrow account to continue to pay only Greece's remaining private bondholders (most of them euro area banks) — while stopping all payments to cover the Greek budget deficit — might appeal to euro area leaders. Even if it chose to stay in the euro, the Greek government would have to balance spending and revenues immediately, ushering in even more austerity than entailed by the IMF program. While the euro area does not want Greece to end its IMF program and even less to exit the euro, it holds a stronger hand than Athens holds in this new round of brinkmanship.
Ahead of Greece's new elections, the euro area and the Troika (the EU, the ECB and the IMF) will thus employ the Irish referendum strategy by rejecting Tsipras's bluff and declaring the IMF program non-negotiable – and adding that a failure by Greece to adhere to it will cancel financial support and drive Greece from the euro area.
We are already seeing this strategy put in motion. In March, the IMF noted that "Greece has little if any margin to absorb adverse shocks or program slippages.3" But it remains unlikely to sanction any postponement of implementation of its program. This reality was acknowledged by IMF managing director Christine Lagarde in a speech on May 7, in which she noted that while balanced fiscal policies are important, countries under severe market pressure [ including Greece] have no choice but to move faster4." A chorus of voices from Berlin and Frankfurt have been equally clear. Chancellor Angela Merkel has explicitly stated that Greece must carry on with the IMF program to receive financial assistance5. Guido Westerwelle, the German foreign minister, was even more explicit in raising the specter of a euro exit: "We want Greece to stay in the euro area," he said. "Whether it stays in the euro area is in the hands of Greece." 6 Finance Minister Wolfgang Schäuble noted that "If Greece decides not to stay in the euro area, we cannot force Greece."7 Austrian Chancellor Werner Faymann has said that the "exit option" remains on the table in Europe: "Every country can decide to leave the common euro area," he said. "Of course Greece can as well. You just have to know what it means — and the Greeks will have to consider that."8 The ECB's Jörg Asmussen has also already been unequivocal, telling Handelsbladt that Greece has no choice but to stick with its IMF program "if it wants to remain a member of the euro area."9 There is also the option that the euro area will – using the escrow account – try to block funding from Greece before the next elections10 to ram home their message.
Whether this "shock therapy" will influence the Greek electorate is an open question. If cheap rhetoric about the "end of austerity" is the prevailing narrative of the next campaign, Syriza and others may well do even better. But if a second Greek election campaign is about whether to stay inside or outside the euro, the parties committed to the IMF bailout may do better than they did this month and the euro area's "Irish referendum strategy" will have been vindicated. Opinion polling persistently shows that 60-70 percent of Greeks want to stay in the euro. Implicitly putting the euro on the ballot might also reduce the record high 35 percent abstention rate on May 611. One thing is sure, though. Volatility will remain in the weeks ahead. Indeed euro area policy makers are exploiting the chaos to make the choice unmistakable for Greek voters.
If this strategy fails and Syriza and other anti-IMF program parties again win, then the euro ara will likely resort to its ultimate strategy from Cannes last year.
It was then that Prime Minister George Papandreou surprised Europe by suddenly calling for a referendum on Greece's austerity program. That announcement, which occurred just before the G-20 Summit on the Cote d'Azur, forced Papandreou's rivals in the New Democracy to share the political responsibility with his own Socialist party for implementing the IMF program. Previously, New Democracy and its leader Antonis Samaras had cynically refused to share responsibility for the program with PASOK. Indeed he disingenuously claimed that the program could be renegotiated. Papandreou's calculation was that a call for a referendum would expose the emptiness of Samaras's claim and force him to join a national unity government instead.
Later, at the Cannes summit, Papandreou probably got more than he bargained for. Both Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France made it clear that a rejection of austerity in the referendum would force Greece to leave the euro area.12 Papandreou's gambit worked, setting in motion the formation of a national unity government under the technocrat Lucas Papademos only a few days later. PASOK was thus relieved of the sole political responsibility of implementing the IMF program, and Greece won some short-lived but much needed political stability enabling it to negotiate a new program with the largest sovereign debt restructuring in history in the form of a Greek bond swap in early 2012.
Thus if the anti-IMF parties win the next election, the Greek political establishment will likely wake up and seek ways to expand the parliamentary support base for the tough economic policies it knows are inevitable. Remember that Syriza and the Independent Greeks parties are similar to the political position of Samaras before the New Democracy joined the unity government last year. They claim to be "pro-European" and supportive of Greece remaining in the euro. But they also reject the demands for further austerity and structural reforms that represent the price the Greeks will have to pay to follow that path. Only the two most extreme parties in Greece, the hard-core communist KKE with 8.5 percent of the vote on the left, and the extreme-rightwing Golden Dawn with 7 percent of the vote on the right actively advocate the departure of Greece from the euro.
Will the three self-professed pro-European parties come to the same conclusion as Samaras last year when international realities begin to sink in? So far, Tsipras and Syriza are talking a good game. They claim that Greek voters have "clearly nullified the [IMF] loan agreement,"13 under the assumption that the voting result can force economic concessions. When it is made clear to them that this is not the case, will they change their minds? Or will they stand by these pledges, when the Greek government runs out of cash as early as the end of June14 and is speeding toward complete economic collapse as a result of a euro exit? Samaras changed his mind when confronted with this question last November. The euro area will be betting as a last option that Greece's new populists will do the same. They are counting on the parties to stay in Europe and not walking away from history and joining the Levant.
The outcome is uncertain, and Greece may have to enter a more acute phase of ungovernability, perhaps precipitated by a retail customer bank run or other highly visible signs of imminent economic collapse, before people like Tsipras change their minds.
The euro area's ultimatums are ushering in a volatile new phase of the euro area crisis, increasing the risk of Greece leaving the euro area. Brinkmanship is entering a new and more unpredictable level. But this is a case of the democratic process in Greece coming to terms with the cold facts of the challenges it faces. Greece has now had its "first TARP vote" and must now choose which route to take, but with eyes open toward the consequences of its decision.
Euro area leaders face a similar reckoning. If they let Greece go, they must also make a new quantum leap in economic and political integration for the remaining members of the common currency. It would be reckless to force Greece out without adopting the type of 10-year plan for euro area integration called for by Mario Draghi, the ECB president, including steps like a banking union and a road map toward eurobonds and a common fiscal policy.
12. At the time, I described the events here /realtime/?p=2493.